Chapter 3

The Accounting Information System

Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
 The Accounting Information
System

Accounting Accounting Cycle Using a Appendix 3A-

Information System •Identifying and Worksheet Using
recording Reversing
•Basic terminology •Adjustments
entered Entries
•Debits and credits •Journalizing
•Work sheet •Accruals
•Accounting equation •Posting columns
•Financial statements •Trial balance •Prepayments
•Preparing financial
and ownership •Adjusting entries statements from a •Summary of
structure work sheet
•Adjusted trial balance reversing entries
•Closing entries
•Closing
•Monthly
•Post-closing trial statements, yearly
balance closing
•Reversing entries
2
•The accounting cycle
 Basic Terminology
• Event: The cause of changes of assets,
liabilities, and equity

• Transaction: A transfer or exchange between

two or more entities or parties

• Account: Where transactions are recorded

– A separate account is used for each asset,
liability, revenue, expense, gain, loss and
capital (owner’s equity)

3
 Basic Terminology
Permanent accounts (or “real” accounts)
• Asset, liability, and equity accounts
• Appear on the balance sheet
• Permanent accounts are not closed at year end
Temporary accounts (or “nominal” accounts)
• Revenue, expense, and dividend accounts
• Revenue and expenses are on the income
statement; dividends are on the equity statement
• Temporary accounts are closed at year end

4
 Basic Terminology
Journalizing and Posting
• A Journal is a book of original entry for all
transactions
• The General Journal is a chronological listing of
transactions expressed as debits and credits to
particular accounts (known as a journal entry)
• Special Journals are used to summarize
transactions with common characteristics
(e.g. cash receipts, sales, purchases)
• Posting: when the transaction information entered
in the journal is transferred to the general ledger
5
 Basic Terminology
Ledger
• Book (electronic database) containing all
accounts
• Each account has a separate page
• General ledger contains all asset, liability, and all
equity related accounts (capital, revenue, and
expenses)
• Subsidiary ledger contains details related to a
specific general ledger account (example:
accounts receivable subsidiary ledger) details of
a/r; a/p.
6
 Basic Terminology
Trial balance
• Listing of all accounts and their balances
from the general ledger at a given point in
time
• Objective: prove the mathematical equality
of debits and credits after posting (i.e. to
ensure general ledger is in balance)
• Prepared after end of period adjustments
(called Adjusted Trial Balance) and possibly
after closing entries (called Post-closing
Trial Balance) (just real accounts)
7
 Basic Terminology
Adjusting entries
• Entries made at the end of an accounting period
• Brings all accounts up to date on an accrual
accounting basis
• Ensures that revenue recognition principle are
followed and that proper matching occurs
• Four classifications of adjusting entries:
Prepayment Accruals
1. Prepaid expenses 2. Accrued revenues
3. Unearned revenues 4. Accrued expenses
8
 Basic Terminology
Financial statements
• Final summaries of the accounting data for a specific
time period
• Four statements:
• Balance Sheet - shows financial condition at a
specific date (SFP under IFRS)
• Income Statement* - measures the results of
operations during a period of time
• Statement of Cash Flows - shows sources and
uses of cash
• Statement of Retained Earnings (Statement of
Changes in Equity under IFRS)
* IFRS requires a Statement of Comprehensive Income
that can be prepared as a single statement or two
separate statements
9
 Debits and Credits
Debit (Dr.) Credit (Cr.)
To record or enter an To record or enter an
amount on the left side amount on the right side
of a general ledger of a general ledger
account account
• This system of recording transactions is referred to as
the double-entry accounting system; the two-sided
effect of each transaction is recorded in appropriate
accounts
• When a transaction is “in balance”, the debits equal the
credits
• Debits and credits do not mean “increases” and
“decreases”
10
 The Accounting Equation

Assets = Liabilities + Shareholders’ Equity

Assets = Liabilities + Capital + Retained Earnings*

*Retained Earnings = Revenues – Expenses – Dividends

Assets = Liabilities + Capital + Revenues – Expenses – Dividends

11
The Rules of Debit and Credit

• To increase the balance of any account,

record the amount in the normal balance
column
• To decrease the balance of any account,
record the amount in the column opposite to
its normal balance
• When any transaction is correctly recorded,
the accounting equation will remain in
balance

12
 The Rules of Debit and Credit

Account Debit Credit

Assets Increase Decrease

Liabilities Decrease Increase

Shareholders’ Equity Decrease Increase

Revenue Decrease Increase

Expenses Increase Decrease

13
Financial Statements and
Ownership Structure

14
 The Accounting Cycle: Steps
• Analyse the transaction
• Journalize the transaction
• Post the transaction to general ledger (and sub-
ledgers) accounts
• Prepare the (unadjusted) trial balance
• Prepare necessary adjusting journal entries
• Prepare the (adjusted) trial balance
• Prepare financial statements
• Prepare closing journal entries for the year
• Prepare post-closing trial balance (optional)
• Prepare reversing entries (optional)

15
 Recording a Transaction:
Shares are issued for $3,000 cash

Assets = Liabilities + Shareholders’ Equity

+ $3,000 + $3,000

To record this transaction as a journal entry (in General

Journal):
Dr. Cash $3,000
Cr. Common Shares $3,000
These amounts are then posted to the general ledger

Cash Common Shares

3,000 3,000
16
 Preparation of Trial Balance
PIONEER ADVERTISING AGENCY INC. at October 31, 2010

Account Debit Credit

Cash Cash 80,000
80,000 Accounts Receivable 72,000
Advertising Supplies 25,000
Notes Payable Prepaid Insurance 6,000
Office Equipment 50,000
50,000 Notes Payable 50,000
Accounts Payable 25,000
Dividends Unearned Service Revenue 12,000
5,000 Common Shares 100,000
Dividends 5,000
Revenue Service Revenue 100,000
Salaries Expense 40,000
100,000 Rent Expense 9,000
TOTALS 287,000 287,000
17
 Preparation of Trial Balance
• From the previous example, we can see that
the trial balance is “in balance”
• However, the trial balance only proves the
mathematical accuracy of the ledger
• Errors may still exist such as the following:
1. Transaction not recorded
2. Journal entry not posted
3. Journal entry posted twice
4. Incorrect accounts used in either the
journal or posting
5. Offsetting errors made during recording
18
 Adjusting Journal Entries
• Adjusting entries ensure that revenue
recognition and matching are followed within
the period
• Reasons for adjusting entries include:
– To record those events that are not
journalized daily
– To record those costs, which expire with
time and are therefore not recorded
– To record item previously unrecorded
• Adjusting entries are required each time
financial statements are prepared 19
 Adjusting Entries
Prepayments
1. Prepayments made in
cash and recorded as
assets before item is used
(Prepaid Expenses) (prepaid
Rent)
2. Revenue received in
cash and recorded as
liabilities before being
earned (Unearned Revenue)
Accruals
3. Revenues earned but not
yet received in cash and not
recorded (Accrued Revenues)
4. Expenses incurred but
not yet paid in cash and not
recorded (Accrued Expenses)
20
 Adjusting Journal Entries
• Prepaid expenses expire either with the passage
of time (e.g. rent and insurance) or by being used
and consumed (e.g. supplies)
• Example: Company paid $6,000 for one year
insurance when coverage begins October 1, and
debited Prepaid insurance for $6,000
• Adjust for Prepaid Insurance on Dec. 31:
Dr Insurance Expense 1,500
Cr Prepaid Insurance 1,500
($6,000/12 * 3)

21
 Adjusting Journal Entries
• When payment is received from customers for
services (or goods) that will be provided in a future
accounting period, a liability (unearned revenue) is
recognized
• e.g. Rent, magazine subscriptions, deposits
• Example: Company received $12,000 for four
months’ advertising services that begins Oct. 1.
$12,000 was credited to unearned revenue
• Adjustment required on December 31:
Dr Unearned Revenue 9,000
Cr Service Revenue 9,000
($12,000/4 * 3)
22
 Adjusting Journal Entries
• Expenses must be accrued when they are
incurred; also revenues must be recorded as
earned
• Accruals required: interest expense, salaries
expense, bad debts expense, interest earned
• Example: assume on January 5, a company
pays $20,000 for salaries which includes
$10,000 of salaries for December
• Adjustment required on December 31:
Dr Salaries Expense 10,000
Cr Salaries Payable 10,000
23
 Closing Entries
• Closing entries are made to close all nominal
accounts (revenue and expense accounts) for
the year
• The balances in these accounts are
transferred to a clearing account (Income
Summary)
• The balance in Income Summary represents
net income or net loss for the period
• Real (or permanent) accounts are not closed
• The Dividends account is closed to retained
earnings
24
 Closing Entries
The following closing entries are made (assume
net income for the year):
1. Income Summary $$$
Expense Accounts (Individually) $$$
2. Revenue Accounts (Individually) $$$
Income Summary $$$
3. Income Summary $$$
Retained Earnings $$$
4. Retained Earnings $$$
Dividends $$$

25
 Scheme of Closing Entries

Ret. Earnings

Dividends Income Summary

4 3

Expense Revenue

1 2

26
 Closing Entries: Inventory

• In a periodic inventory system, closing entries

are made to record cost of goods sold and
ending inventory
• In a perpetual inventory system, such entries
are not required

27
 Periodic Inventory:
Closing Entry
Collegiate Apparel Shop has the following
balances at year end. The company uses a
periodic inventory system.
Beginning Inventory $ 30,000
Purchases (gross) $200,000
Transportation-In $ 6,000
Purchases Returns $ 1,000
Purchase Discounts $ 3,000
Ending Inventory $ 26,000

28
 Periodic Inventory:
Closing Entry
First Step: Determine Cost of Goods Sold
Beginning Inventory $ 30,000
Purchases $200,000
Less: Purchase returns $1,000
Purchase discounts 3,000 4,000
Net Purchases 196,000
Plus: Transportation-In 6,000
Cost of Goods Purchased 202,000
Cost of Goods Available for Sale 232,000
Less: Ending Inventory 26,000
Cost of Goods Sold $206,000
29
 Periodic Inventory:
Closing Entry

Account Dr. Cr.

Cost of Goods Sold $ 206,000
Inventory (Ending) $ 26,000
Purchases Returns $ 1,000
Purchase Discounts $ 3,000

Purchases (Gross) $ 200,000

Transportation-in $ 6,000
Inventory (Beginning) $ 30,000

30
 COPYRIGHT

Copyright © 2010 John Wiley & Sons Canada, Ltd.

All rights reserved. Reproduction or translation of
this work beyond that permitted by Access Copyright
(The Canadian Copyright Licensing Agency) is
unlawful. Requests for further information should be
addressed to the Permissions Department, John
Wiley & Sons Canada, Ltd. The purchaser may make
back-up copies for his or her own use only and not
for distribution or resale. The author and the
publisher assume no responsibility for errors,
omissions, or damages caused by the use of these
programs or from the use of the information
contained herein.

31